Seeking Light in the Heat of Energy Investing

An Exxon Mobil liquefied natural gas terminal in Texas.Credit
Michael Stravato for The New York Times

Energy independence. Oil exports. Fracking. Electric cars. Solar power. And as of last week: the heat dome. These are phrases that are bandied about, sometimes dividing people along political lines. But all mean one thing: this is a boom time for the United States energy sector, from pulling it out of the ground to moving it around the country to finding ways to use less of it.

It took last week’s heat dome, with the searing heat outside and that equally uncomfortable arctic blast when you walked inside, to get me thinking about energy — and not just how much of it I was consuming. I started wondering about the investment opportunities and the associated risks around the boom in oil and gas production and the push for alternative sources of energy. So many people seemed so sure that investing in energy was the way to go, and naturally that spooked me.

The United States is set to become the world’s leading producer of natural gas in 2015 and oil in 2017, according to the International Energy Agency, and there is money to be made in getting both out of the ground, to the coasts and on ships. Some energy companies and new technologies will surely be wildly successful, while others that seem promising will no doubt fail. But as people rush to invest in energy, how should they think about what they are doing?

“The energy renaissance is very similar to the Internet renaissance that started to develop in 1985,” said Anton Bayer, chief executive of Up Capital Management. “In order to find the next Apple, you need to find the next industry. Then you need to drill down to find where the innovation is.”

I thought that was an apt way of describing this moment. Looking back, it’s easy to talk about what a great investment Apple has been, but as a youngster in the early 1980s my bet would have been on the Commodore 64, with its eight-tracklike game cartridges, that I had in my bedroom.

What do investors need to keep in mind when they are looking for the Apple of energy, not the Commodore?

FINDING ENERGY The technology that has allowed horizontal drilling — as opposed to drilling straight down — has radically changed how oil and natural gas are extracted. Yet drilling has always been boom and bust; five years ago, the price of natural gas was over $13 per million British thermal units before beginning a steady fall to its low of less than $2 per million B.T.U. in April 2012.

There are less speculative ways to benefit than investing in the exploration and production boom. Jason T. O’Connell, director of equity research at Boston Private Bank & Trust, said he had been talking to clients about companies like Schlumberger, Cameron International and Dril-Quip that make the equipment to reach the oil.

“It’s become a lot harder to get this stuff out of the ground or from under the sea,” he said. “There is an increasing capital intensity that’s a little more insulated from the price of oil.”

He said he was also interested in companies that work in areas related to drilling, like those that look to reduce the environmental impact of newer types of drilling, including hydraulic fracturing, which pumps high-pressured fluids into rock to increase a well’s production. Fracking has helped increase the productivity of wells, but it has drawn concern about what the process does to drinking water and the areas around wells.

He said he liked companies like Waste Connections and Clean Harbors that could benefit from energy companies paying them to prevent damage and also to clean up if damage occurs.

Investments in the alternative energy sector bear the risk of falling political support.Credit
J. Emilio Flores for The New York Times

“In the past, refiners have needed a robust economy to make strong profits, but because of the new export market brought about by the American oil renaissance, refiners are making a lot of money right now, in a mediocre economy,” he wrote. “As the U.S. economy strengthens, the refining industry should enter a sweet spot of profitability.”

Yet Matthew Rubin, director of investment strategy at Neuberger Berman, said he had urged clients to look at companies with track records, and warned about those that have rushed to make money in the Bakken shale around North Dakota.

“The evolution of wealth there is being talked about as the new Saudi Arabia,” Mr. Rubin said. “Where the dangers and pitfalls exist is looking at companies that are much more speculative in nature, that don’t have the technology to do the fracking.”

MOVING ENERGY Once the oil or natural gas is out of the ground, it has to go somewhere.

When natural gas prices hit bottom last year, the rush to find even more of it slowed. But there is still money to be made moving it from the center of the country to where it is needed. This is not just in the United States, where the price has risen to nearly $4 per million B.T.U.'s., but also in countries like Japan, where the price is four times as high. The challenge is getting the gas there.

“Our national policy had been shipping in, so all the refineries are on the coastline,” Mr. Bayer said. “The Canadian rail disaster and battles over pipelines are indicative of the strains to get oil and gas within the country.”

He said he favored investing in transportation, largely through master limited partnerships that own pipelines. Such companies, known as M.L.P.'s, are popular and have experienced a run-up in value. But he said that they were also the main way for average investors to invest in transporting oil and gas.

If predictions are accurate, there will be more pipelines. “A tremendous amount of infrastructure needs to be built,” Mr. Rubin said. “We’re finding more energy, but how do you move it from one place to another?”

He said a benefit of investing in pipelines was that they function like toll roads, moving oil and natural gas around the country, and are less dependent on the price of the commodity itself.

Not everyone is bullish on M.L.P.'s. Mr. O’Connell said clients who invested in them to get higher yield might not understand what they were getting into if the sector went through a soft patch. “We tend to tread lightly on taking large positions in investments that pay a nice dividend,” he said. “We’re more focused on dividend growth than dividend yield.”

SPECULATIVE ENERGY What surprised me was that few of the analysts I spoke with were investing heavily in the types of alterative energy — solar, wind, electric-powered cars — that are promoted as the future of energy. One reason for this was a fear that if political support for these industries shifted, the companies themselves could falter.

“Solar, wind, clean coal — they’re more popular from a political perspective,” said Thorne Perkin, managing director of Papamarkou Wellner Asset Management, which recently hosted a symposium on American energy independence. “The political landscape is very important. An administration can be very helpful or very hurtful in pushing these industries along. There are so many unknowns.”

Mr. Bayer said he believed that natural gas had the potential to become a de facto alternative energy and had been talking to clients about investing in companies that can bring it to consumers. One is Westport Innovations, which makes engines fueled by natural gas, including those in Ford automobiles.

But for all of his excitement, he said he advised clients not to forget that this boom might not happen as planned. “The investor needs to be cognizant that this is a lot of risk and a lot of volatility,” he said. “The Internet made progress in the ‘70s, but it wasn’t until the ‘80s when it really started to grow. With the energy sector, it’s like ’82 or ’83 with the Internet.” Or right when the Commodore 64 was the computer to own.

Correction: August 6, 2013

A picture caption on July 27 with the Wealth Matters column, about identifying good investments in energy, misidentified the location of the Exxon Mobil liquefied natural gas terminal shown. It is in Texas, not Louisiana, though the photograph of it was taken from Louisiana soil.

A version of this article appears in print on July 27, 2013, on Page B1 of the New York edition with the headline: Seeking Light in the Heat of Energy Investing. Order Reprints|Today's Paper|Subscribe